What does Google gain from having purchased On2?

At the end of business last Friday, Google announced it had completed the transaction to acquire On2 Technologies, the maker of Web video encoding software and codecs, for a deal that was finally valued at $124.6 million. On2 was a small company that was, in recent quarters, losing small amounts of money. It was attempting to become lucrative at some point through the licensing of a new generation of its VPx codec platform, called VP8 announced way back in the fall of 2008. Customers were supposed to have included Move Networks and Skype.

It's the type of business model that only a small startup company could profit from to any significant degree; and it's the type of model that normally a huge company the size of Google would only purchase in order to shut down, perhaps to disable a competitor. But none of the usually suspected motives for a major player acquiring a minor provider make immediate sense when applied to Google and On2.

Perhaps that's why when the Free Software Foundation on Friday posted an open letter to Google urging the company to completely give away the crown jewel of On2's portfolio, VP8, to the free and open source community, that solution seemed about as plausible as anything else on the table. Why would Google make such a move? As the FSF describes it, to promote a single, ubiquitous standard that could end the Web's reliance upon Flash, Adobe's proprietary streaming platform that powers Google's YouTube.

"Because patent-encumbered formats were costly to incorporate into browsers, a bloated, ill-suited piece of proprietary software (Flash) became the de facto standard for online video. Until we move to free formats, the threat of patent lawsuits and licensing fees hangs over every software developer, video creator, hardware maker, web site and corporation -- including you," writes the FSF. "You can use your purchase of On2 merely as a bargaining chip to achieve your own private solution to the problem, but that's both a cop-out and a strategic mistake. Without making VP8 a free format, it's just another video codec. And what use is another video format with patent-limited browser support?"

On2 Technologies created this comparison between its own VP8 codec and H.264.

The problem is, it's of some use. Although Flash is a technology that does belong to Adobe, Google is actually in a good position to continue using it for some time to come, with all the benefits coming to it directly. Reportedly Google has already paid Adobe a one-time license fee for perpetual rights to the encoding; and since YouTube uses HTTP progressive streaming rather than the RTMP streaming protocol maintained by the Open Screen Project, it doesn't owe a license fee for using a Web standard. Meanwhile, one of the leading manufacturers of Flix encoding software for VP6 -- one of the codecs Flash has supported since version 8 -- is On2, so conceivably there's a little revenue to be made from perpetuating the VPx platform just as it is.

Back in August 2008, just as On2 was announcing VP8 for the first time, its executives convened a conference call with analysts (transcribed by Seeking Alpha). It was there that the company offered the first clues as to what it was really trying to build, going beyond the relatively low-profit licensing model of its chief competitor, the MPEG Licensing Authority, which manages H.264.

As acting CEO Matt Frost told analysts at the time, "We have licensing flexibility that the MPEG LA doesn't. If you want to license H.264, there's one licensing model and if you try to negotiate for a different licensing model, you're not going to get it. With On2, we are partnered with many different people using video applications and we're very open to different licensing structures with them, and it's something that many of our biggest customers have found particularly attractive about us."

On2 expected VP8 to compete against H.264 for the rest of its existence, Frost went on, but the company would not limit itself to licensing on a typical, annual basis as does MPEG LA. Frost wasn't looking to advance Web standards here: He was making a play for video systems manufacturers, companies like Vizio and Panasonic that are integrating Internet video into HDTVs. It doesn't make sense to apply an annual royalty model to a more wholesale business.

So when Broadcasting & Cable found On2 the very next month demonstrating at a major video manufacturers' conference, it wasn't with the idea of competing with Flash on YouTube. On2, remember, had an interest in Flash on YouTube. Instead, it was demonstrating a service, along with Move Networks, for potential customers such as Disney and NBC Universal to stream not-so-high-definition content onto set-top boxes and built-in program guides -- a way for content studios to advertise their content directly in TV sets.

Maybe On2 as a company wasn't going anywhere in the past few years, but that doesn't necessarily mean On2's technology was a bad idea. Anyone who's noticed Vizio's Forge product line commercial during NBC's Olympics coverage in recent days (you know, the one your wife or girlfriend warns you about because it starts with Beyoncé in a short, red dress) knows that the selling point for high-end HDTVs these days is functionality. Internet apps are delivering a new class of functionality to HDTVs, and there's a lucrative new market in the platforms for that functionality.

So maybe giving away VP8 would help Google score some points with Web browser fans; but we may be looking in the wrong category for clues as to Google's reasoning here. It may not care about VP8 as a PC/netbook/smartphone Web codec at all, and could conceivably continue to promote H.264 as the HTML5 codec of choice as long as it wishes. Google's chance at a platform play could have nothing to do with the Web at all. Problem is, giving away VP8 to the Web would mean giving it away everywhere, and that's something that looks less and less likely, the more you consider the viability of VP8 outside the Web.